This Company Has a Lock on a Rare Commodity in the Permian Basin: Beds

Oil and gas from the Permian Basin of West Texas and New Mexico has catapulted the U.S. into a petroleum superpower. One problem: Finding a place to house workers in the middle of nowhere.

That creates a unique opportunity for Target Hospitality Corp., which will be created through the three-way merger of two flexible-housing operators, Target Lodging and Signor Lodging, along with Platinum Eagle Acquisition Corp (ticker: EAGL). The latter is a blank-check company, or SPAC, that raised money to find an investment, and its shares will automatically convert to Target Hospitality shares if the deal is approved in the first quarter of 2019.

The combined company, whose main clients include blue-chip oil-and-gas companies such as Schlumberger, Chevron, and Royal Dutch Shell, provides full-service communities in locations where ordinary housing is scarce. Those communities include everything from bedrooms to swimming pools to dining halls outfitted with premium catering. The communities are comprised of portable homes, allowing them to be moved around the country if needed.

Importantly, some 81% of Target Hospitality’s current footprint is in the Permian Basin, where it already has 15 lodges with 8,800 beds. That makes it the region’s largest player by far, with the number two provider having just a few communities and oil-and-gas companies generally not building their own.

What makes the Permian Basin so attractive? The region has always had enormous reserves, comparable to countries in the Middle East. But in the last few years, technologies such as horizontal drilling and fracking have allowed companies to reach areas deep underground that were previously inaccessible. In the process, output exploded even as it declined in other U.S. oil fields.

To ensure exploration remains profitable, companies in the region have focused on projects that work even at depressed oil prices. Target Hospitality’s clients have breakeven prices of West Texas Intermediate crude oil in the $30 to $40 range versus the latest price of $57.

What’s more, Target Hospitality has rock-solid contracts with clients that offer added stability. Some 83% percent of its contracts are “pay or take” – meaning clients pay Target Hospitality for full capacity whether rooms are used or not. And the contracts have a weighted-average term of 40.6 months.

Why are clients so eager to commit to Target Hospitality? One reason is that it can be challenging to attract skilled workers to remote areas like the Permian Basin without a guarantee of comfortable housing. The bitter memory of layoffs a few years ago and concerns of being stranded left many workers skeptical about taking a chance. Indeed, a recent Bloomberg report indicates that labor is perhaps an even bigger concern than oil prices for operators in the Permian Basin.

Of course, some observers question whether the rapid growth in the Permian Basin is due for a halt. But any such slowdown looks likely to be temporary. For instance, there is currently a bottleneck caused by a shortage of pipelines. There are multiple pipeline projects due to open up in 2019 and Target Hospitality’s clients are top-tier firms most likely to gain quick access.

Another advantage Target Hospitality will have over rivals: vertical integration. Currently, Signor Lodging, one of the two housing companies in the deal, focuses only on accommodations and outsources dining services. But after the merger with Target Lodging, which has its own catering business, the combined company will have a comprehensive offering with lower costs and more appeal to clients. Revenue will also be diversified between catering at 27% and facilities at 73%.

All of that translates to healthy growth in Ebitda at an annualized rate of 25% from 2016 to 2019. Looking to next year’s Ebitda, investors can also be confident because 88% of projected revenue is tied to executed contracts.

And there is plenty of room for Target Hospitality to expand, both in its existing business or via acquisition. The combined company will have net debt equal to a modest two times 2019 projected Ebitda. That could help it scoop up competitors in the Permian Basin or elsewhere while leaving the door open for dividends or share buybacks.

In terms of valuation, Target Hospitality is priced at an enterprise value, adjusted for debt, of 8.4 times 2019 projected Ebitda. That compares with multiples of 11.1 times for Mobile Mini, a portable-storage provider, and 9.1 times for WillScot, which offers mobile office and storage products.

Investors should also note that Platinum Eagle CEO Jeff Sagansky has a proven track record in the industry. He was in fact a founder of another SPAC, Double Eagle, which acquired WillScot. Shares of WillScot are up about 40% since they began trading under the ticker WSC a year ago.

With a lock on the Permian Basin and a carefully-planned growth strategy, Target Hospitality offers investors a rare chance to sleep well at night.